Paper trading was going to be my "secret weapon." It was going to allow me to crush the stock market, and in the process, reap me tens, if not hundreds of millions of dollars. That was the plan I hatched in the summer of 1982 at the age of fifteen.
Would it surprise you if I told you that the plan didn't exactly unfold as I had wished?
My paper trading went on for three years until I was old enough to actually buy my first stock, and though previously I had made a mint on paper, within six months of funding my real account I had lost all my money.
For many who are new to the stock market, paper trading often seems like a great way to learn how to invest because you don't have to put any real money at risk. Most brokerages today have the ability to create a fully functioning paper trading account for you, using real market data, with which you can test out your strategies to see if they will pay off.
However, no matter how realistic a paper trading account is, there are certain factors that just can’t be accounted for, like slippage, bad fills, and lack of liquidity. But the most important thing that paper trading accounts lack is a sense of risk.
Investing without risk is not really investing. It’s like trying to learn to swim without water, or practicing a key note speech in your living room. No matter how well you think you prepared, until you go out onto the stage of an auditorium and face a room full of people, you’ll never know how you will perform.
And no matter how well your paper trading goes, it lack emotions – which are triggered by risk – and emotions in investing will often change your thought process and make you deviate from even the best laid plans.
Hope, that a makes you hold a losing stock, waiting for it to come back to profitability.
Fear, that you will miss out on a winning stock if you don’t buy it now.
Greed, which keeps you from selling a winning stock even though it has hit your profit target.
Confusion, when a stock doesn’t move in the direction you think it should.
All these emotions, and more, are absent when paper trading, providing a false sense of security and an illusion of expertise that quickly disappears when real money is on the line.
So instead of paper trading, a better alternative which allows you to learn more, learn faster, and get a truer sense of how you will react in a variety of market conditions, is to open a real money account and initially only invest in small amounts.
Testing your investment strategies and theories with fifty, twenty-five, or even ten shares, in a funded account, will focus you on how stocks react and will give you a feel for the stock market that you just can’t get without risking real money, and here’s why.
Our interest and focus is heightened when we have something to win, or something to lose. Nobody cares about the outcome of a game between two last place teams on the final Sunday of the NFL season; but put a fifty-dollar bet on it with your buddy, and suddenly it’s the most important game of the year.
Having even a little bit at risk on your stock positions will engage you in a way that just won’t happen without a real, funded account, and will give you a more realistic view of how you handle the ups and downs of the market from an emotional standpoint.
Then once you find a strategy that works, and that you are comfortable with, you can scale it up to a level that fits your risk tolerance profile.